Shortly after the publication of his now-famous book, The Road to Serfdom, in 1944, Austrian economist Friedrich A. Hayek was in the United States on a lecture tour. In April 1945, he appeared on an NBC radio broadcast during which, in response to a question about whether the American Federal Reserve System was consistent with a free society, he stated, “That the monetary system must be under central control has never, to my mind, been denied by any sensible person. It is part of that [government] framework within which competition can work.” And when asked whether the Federal Reserve was “socialistic in character,” Hayek replied, “Do not make me responsible for all the nonsense which has ever been talked by anybody.”

Fifteen years later, in his treatise The Constitution of Liberty (1960), Hayek argued, “The experience of the last fifty years has taught most people the importance of a stable monetary system…. The inflationary bias of our day is largely the result of the prevalence of the short-term view” fostered and popularized by Keynes through the “fundamentally antiliberal aphorism, ‘In the long run we are all dead.'”

Hayek stated that discretionary monetary policies to maintain “full employment” had produced nothing but dangerous inflationary tendencies throughout the Western world. It was understandable, therefore, that many now looked back wistfully to the earlier era of monetary stability under the gold standard and advocated its return. But, he declared, “It is important to be clear at the outset that this is not only politically impracticable today but would probably be undesirable if it were possible.”

Instead, Hayek proposed a government monetary authority that would pursue “the reasonable goal of a high and stable level of employment” through “aiming at the stability of some comprehensive price level” by means of adjusting the quantity of money in the economy to any changes in the general demand for money by transactors in the market. Thus, Hayek advocated both a general monetary “rule” — stability of a “price level” — and a monetary central-planning authority possessing the discretion to modify the supply of money to reflect changes in the demand for money.

Another 15 years later, however, Hayek’s views on money and monetary policy radically changed. About a year after being awarded the Nobel Prize in economics in 1974, he delivered a lecture on “International Money” in September 1975 at a conference in Switzerland. In early 1976, it was published in London as a monograph under the title Choice in Currency: A Way to Stop Inflation. He explained that under the influence of Keynes and Keynesian domination of monetary and macroeconomic policy, governments were invariably guided by short-run goals in the service of various special-interest groups. The consequence was the constant abuse of the printing press and a resulting price inflation to feed the seemingly insatiable demands of privileged and politically influential groups.

Hayek now concluded that some method had to be found to free the ordinary citizen from the government’s monopoly control of the medium of exchange. The answer, he suggested, was allowing individuals the freedom to use whatever money they chose, instead of their being captives of the increasingly depreciated monetary unit imposed on the market by the government:

“There could be no more effective check against the abuse of money by the government than if people were free to refuse any money they distrusted and to prefer money in which they had confidence. Nor could there be a stronger inducement to governments to ensure the stability of their money than the knowledge that, so long as they kept the supply below the demand for it, that demand would tend to grow. Therefore, let us deprive governments (or their monetary authorities) of all power to protect their money against competition: if they can no longer conceal that their money is becoming bad, they will have to restrict the issue.

“Make it merely legal and people will be very quick indeed to refuse to use the national currency once it depreciates noticeably, and they will make their dealings in a currency they trust.

“The upshot would probably be that the currencies of those countries trusted to pursue a responsible monetary policy would tend to displace gradually those of a less reliable character. The reputation of financial righteousness would become a jealously guarded asset of all issuers of money, since they would know that even the slightest deviation from the path of honesty would reduce the demand for their product.”

Hayek’s proposal was for people to have the option to competitively select among the various currencies issued by governments. Later that year, however, Hayek published a short volume, Denationalisation of Money: An Analysis of the Theory and Practise of Concurrent Currencies (1976; revised, expanded edition, 1978), in which he proposed an even more radical idea. He said, “When one studies the history of money one cannot help wondering why people have put up for so long with governments exercising an exclusive power over 2,000 years that was regularly used to exploit and defraud them.”

Hayek outlined a system of free, competitive private banking, outside the control of government, that would supply the money used in the market society. By “private competitive currencies,” however, Hayek did not mean a system of private and independent banks accepting deposits in, say, gold or silver, and issuing coins or paper notes representing fixed quantities of gold and silver, redeemable on demand. Instead, he suggested a system of alternative currencies in which each issuing bank would promise and attempt to keep the value of its private money constant through an expansion or contraction of its currency in circulation.

The criterion for what type of action would be called for in any particular situation would be an index of commodity prices representing a market basket of “widely traded products such as raw materials, agricultural foodstuffs and certain standardized semi-finished products.” When the index began to rise, it would be a signal for that bank to withdraw its currency from circulation, and when the index began to fall, to increase the quantity of its currency outstanding.

Why would a currency of “stable value” be desired by the public? Because, Hayek argued, the requirements of economic calculation and the desire for less uncertainty involving contracts for deferred payments would probably make this the most preferred type of medium of exchange. The possible utilization of alternative competing monies available on the market would act as a restraint on reckless monetary expansion on the part of any bank. The expansionist bank would soon find its money depreciated in relation to other market currencies. Either the bank would have to return to a more conservative loan-making and money-issuing policy or face repudiation on the part of the public. “This is the process by which the unreliable currencies would gradually all be eliminated,” Hayek reasoned.

How would these alternative private monies come into circulation in the first place? Hayek argued that if he were in charge of a bank,

“I would announce the issue of non-interest bearing certificates or notes, and the readiness to open current checking accounts, in terms of a unit with a distinct registered trade name such as a “ducat.” The only legal obligation I would assume would be to redeem these notes and deposits on demand with, at the option of the holder, either 5 Swiss francs or 5 D-marks or 2 dollars per ducat. This redemption value would however be intended only as a floor below which the value of the unit could not fall because I would announce at the same time my intention to regulate the quantity of the ducats so as to keep their … purchasing power as nearly as possible constant.”

Hayek seemed to believe that new, private competing currencies would have the ability to be accepted as money because they would be, at least initially, redeemable in stipulated quantities of already-existing government monies, such as the franc, the mark, or the dollar. But if market participants were interested in moving into an alternative private currency of choice it would be because they were searching for a medium of exchange whose market value was not depreciating, or at least not expected to depreciate as rapidly or over as prolonged a period, as had the government money they had been previously obliged to use.

Hayek’s proposal was open to the following question: Would people be interested in accepting and willing to accept a new money whose present value was represented only by a promised intention to keep its future value stable according to a designated index number and whose initial redeemability was in fixed quantities of a money (or monies) from which people were trying to escape? In other words, was this a procedure and a promise attractive enough for market actors to be willing to accept such a new private money to begin with? Could such a network of private monies ever get off the ground? And why would such private paper currencies be more attractive than private competitive banks operating on the basis of deposits of commodities historically used as money, such as gold or silver?

Another weakness in Hayek’s proposal was his notion of private bank’s manipulating the quantity of their respective currencies to “stabilize” their values as measured by some statistically constructed price index. What Hayek seemed to want private issuers of money to do was what he warned against almost 50 years earlier when the Federal Reserve System had attempted to stabilize the general price level in the 1920s, a policy which he argued had been the central cause of the economic downturn of 1929. (See “Monetary Central Planning and the State, Part 7: Friedrich A. Hayek and the Destabilizing Influence of a Stable Price Level” in Freedom Daily , July 1997.)

Hayek had argued in the late 1920s and the 1930s that such a monetary manipulation in the name of price-level stabilization would distort interest rates, potentially induce investment activities in excess of available savings in the economy to sustain them in the long run, and create the conditions for an eventual economic downturn in production and employment. If a single monetary authority within a national area can create such serious distortions and imbalances, a multitude of private banks each increasing or decreasing their currencies as guided by various price indices could intensify the number of faulty price signals by which investors might be influenced in making their production decisions.

But in spite of such possible criticisms, the crucial role of Hayek’s proposal for the denationalization of money was that it opened a new, serious discussion concerning the possibility for a market-based monetary order free and separate from government management and control. He heralded a new campaign in the fight for freedom:

“What we need is a Free Money Movement comparable to the Free Trade Movement of the 19th century. If we want free enterprise and a market economy to survive … we have no choice but to replace the governmental currency monopoly and national currency systems by free competition between private banks of issue…. The recognition of this truth makes it … a crucial issue which may decide the fate of free civilisation.”

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Dr. Richard M. Ebeling is the recently appointed BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel. He was formerly professor of Economics at Northwood University, president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).

Reading List

Prepared by Richard M. Ebeling

Austrian economics is a distinctive approach to the discipline of economics that analyzes market forces without ever losing sight of the logic of individual human action. Two of the major Austrian economists in the 20th century have been Friedrich A. Hayek, who won the Nobel Prize in Economics, and Ludwig von Mises. Posted below is an Austrian Economics reading list prepared by Richard M. Ebeling, economics professor at Northwood University in Midland and former president of the Foundation for Economic Education and vice president of academic affairs at FFF.